Toolbox is a large garden equipment supplier with retail stores throughout Berlin. Many of the products it sells are bought in from outside suppliers, but some are currently manufactured by Toolbox’s own manufacturing division ‘Hammer’.
The prices (a transfer price) that Hammer charges to the retail stores are set by head office and have been the subject of some discussion. The current policy is for Hammer to calculate the total variable cost of production and delivery and add 30% for profit. Hammer argues that all costs should be taken into consideration, offering to reduce the mark-up on costs to 10% in this case. The retail stores are unhappy with the current pricing policy arguing that it results in prices that are often higher than comparable products available on the market.
Hammer has provided the following information to enable a price comparison to be made of the two possible pricing policies for one of its products.
Steel: the shears have 0.4 kg of high quality steel in the final product. The manufacturing process loses 5% of all steel put in. Steel costs $4,000 per tonne (1 tonne = 1,000 kg).
Other materials: other materials are bought in and have a list price of $3 per kg although Toolbox secures a 10% volume discount on all purchases. The shears require 0.1 kg of these materials.
The labour time to produce shears is 0.25 hours per unit and labour costs $10 per hour.
Variable overheads are absorbed at the rate of 150% of labour rates and fixed overheads are 80% of the variable overheads.
Delivery is made by an outsourced distributor that charges Hammer $0.50 per garden shear for delivery.
A. Calculate the price that Hammer would charge for the garden shears under the existing policy of variable cost plus 30%.
B. Calculate the increase or decrease in price if the pricing policy switched to total cost plus 10%.
C. Discuss whether or not including fixed costs in a transfer price is a sensible policy.
D. Discuss whether the retail stores should be allowed to buy in from outside suppliers if the prices are cheaper than those charged by Hammer.